Group annuities remain a bargain despite falling interest rates

Despite falling long-term interest rates, the price of group annuities remains attractive to sponsors of defined-benefit pension plans. Many are taking advantage of this situation to purchase these products to reduce the risks to which their pension funds are exposed. 

The pension risk transfer market is benefiting greatly. Actuarial consulting firms and life and health insurance companies are increasingly orchestrating large-scale transactions that insiders refer to as “jumbo” deals. These represent group annuity purchases of $750 million or more. 

Annuities, an insurance product that pays a guaranteed monthly income to beneficiaries, help ward off risks such as longevity. With life expectancy on the rise, some plans are concerned about having to pay benefits to retirees for longer than expected. Annuities also enable plan sponsors to offload interest-rate and financial-market risks, as well as inflation risk, in the case of plans offering indexed retirement benefits.

Among the most recent moves in this market, WTW reports that IBM Canada Limited finalized a $1.5 billion buy-out transaction in October 2024. This transaction involves 6,000 members of the IBM Canada plan. A buy-out transaction means that the insurers buy out the plan sponsor's commitments to its members. At the end of such a transaction, the insurers become administrators and are responsible for paying pensions to plan members.

Second largest transaction  

“This is the second largest annuity transaction ever in the Canadian market,” underlined WTW in its Group Annuity Market Pulse - Third Quarter 2024. The firm adds that the transaction was completed with Brookfield Annuity and RBC Insurance. 

Press releases issued on October 31 by each insurer state that RBC Insurance and Brookfield Annuity “will each insure 25 per cent and 75 per cent, respectively, of the pension benefit payments for each of the approximately 6,000 plan participants and beneficiaries.” Both stated that RBC Insurance will act as lead administrator and pay the protected retirement income to all retirees and their beneficiaries, starting May 1, 2025.

There's more to come  

WTW dominated the Canadian pension risk transfer market in 2023, with a 29% share (compared with 20% for its nearest rival, Aon). The firm expects a record year in 2024. “We estimate that an additional $5 billion in group annuities will be transacted in the fourth quarter, bringing the projected 2024 market volume to over $10 billion,” states WTW. Total volume reached $7.8 billion in 2023, as well as in 2022.

Regarding results for 2024, Mathieu Tessier, Vice President, Client Relations and Innovation, Defined Benefit Solutions, at Sun Life, finds it hard to see how the market could do anything but surpass the 2023 results. “Everything would have to come to a screeching halt between now and the end of the year for us not to break the $7.8 billion record,” commented Tessier, in an interview with Insurance Portal at the end of October. 

Among the transactions made public in 2024, RBC Insurance, Sun Life and Desjardins Insurance purchased $923 million in commuted group annuities for members of a Ford Canada pension plan. WTW acted as advisor in this transaction. Tessier noted that this transaction was made public in 2024, but completed in 2023.

Other transactions carried out in 2024 were not made public. Among them, Tessier revealed that Sun Life alone completed a $1.2 billion annuity transaction with a plan sponsor in the second quarter of 2024. In 2023, Sun Life led the market with a 28% share. Sun Life's closest rival in 2023, RBC Insurance, claimed 19%.

From small to large  

Tessier notes that group annuity transactions in the Canadian defined-benefit pension risk transfer market from 2008 to 2024 totalled over $60 billion. “Prior to 2013, the group annuity market was relatively small. Transactions totaled around $1 billion a year,” he recalled. 

In his opinion, what has driven the group annuity market is the large number of pension plans that have long maintained high funding levels. 

Lower rates: not an issue  

Tessier also believes that annuity pricing remains highly advantageous. “Many plan sponsors take advantage of this to reduce the risk of their pension plans,” he notes. 

Tessier is not worried about the lower key interest rate, which the Bank of Canada reduced from 5.00% on April 10 to 3.75% on October 23. He explains that the duration of a group annuity contract is based on a mid-point that fluctuates between 10 and 15 years. “We'll be looking more at bonds with durations of 10 to 30 years, rather than the overnight lending rate,” he explains.

He also pays attention to credit spreads on federal and provincial bonds. He also looks at the credit spreads of corporate bonds, whose yields are generally higher than those of government bonds. 

Nor is he worried about the decline in longer-dated rates. According to Bank of Canada statistics, the average yield on marketable Canadian government bonds over 10 years stood at 3.34% on November 1, 2024, after peaking at 4.07% on October 3, 2023.

Currently, annuity yields are higher than those of a corporate bond portfolio, “especially when you take into account the risks that will be transferred with the annuity…Five or six years ago, annuity yields were closer to those of a government bond portfolio,” he says.

With equal returns between an asset class and a group annuity, the added benefit of transferring risk may be enough to convince plan sponsors to switch from a passively managed investment portfolio to a group annuity, says Tessier.